CFTC Updates Rules on CPO and CTA Compliance Obligations
Commentary by Mark Highman
The CFTC adopted amendments that revise compliance requirements for Commodity Pool Operators ("CPOs") and Commodity Trading Advisors ("CTAs") operating under Regulation 4.7 ("Exemptions").
The amendments include updates to the Qualified Eligible Person ("QEP") definition and new provisions for account statement reporting. The CFTC decided not to impose additional disclosure requirements on Rule 4.7 funds at this time.
Specifically, the amendments:
- increase QEP thresholds. The CFTC raised the financial thresholds under the "Portfolio Requirement" of the QEP definition to reflect inflation. The new threshold requires QEPs subject to the Portfolio Requirement to have (i) $4,000,000 in securities of unaffiliated issuers and other investments (up from $2,000,000) or (ii) $400,000 in exchange-specified initial margin and option premiums for transactions in CFTC-regulated derivatives (up from $200,000).
- permit monthly account statements for funds of funds. The CFTC formalized the option for CPOs operating funds of funds to distribute monthly account statements within 45 days of the end of each calendar month instead of quarterly, aligning with exemptive letters issued by the CFTC in recent years.
- make technical amendments. The amendments included several technical changes to Regulation 4.7 including for cross-referencing and organization.
The rule amendments will take effect 60 days after publication in the Federal Register, with compliance required for the updated QEP thresholds within six months. CPOs that elect the optional monthly reporting schedule for their 4.7 pools must comply immediately upon making that election.
Statements
- Commissioner Summer K. Mersinger said that the CFTC "achieved balance in adopting the amendments to Regulation 4.7." She said, "the Commission avoided the temptation to overregulate under this rule," but expressed concern about the possibility of future expansions to Regulation 4.7. She urged the CFTC to "avoid such future expansions, unless the Commission finds concrete evidence establishing a need for modifications and only after robust discussions with industry."
- Commissioner Caroline D. Pham praised the CFTC for "taking additional time to understand how to best protect market participants and to consider the various disclosure proposals submitted by the public in connection with Regulation 4.7." She emphasized that using regulation to "pick winners and losers" could widen the wealth gap, which would not only "betray the American public's expectation of Washington to create and maintain fair markets," but also "undermine financial inclusion."
Commentary
Here are some considerations on the increase in the Portfolio Requirement thresholds under CFTC Rule 4.7:
- Scope of Investors Affected by the new Portfolio Requirement thresholds. QEPs fall into two categories:
(i) Investors who qualify as QEPs without having to meet the Portfolio Requirement. These include "qualified purchasers" and "knowledgeable employees" who are eligible to invest in funds falling within Section 3(c)(7) of the Investment Company Act. These investors will be unaffected by the increase in the Portfolio Requirement thresholds under CFTC Rule 4.7.
(ii) Investors who are required to meet the Portfolio Requirement in order to qualify as QEPs. These include certain categories of "accredited investor" as defined in Rule 501 under the Securities Act of 1933, who are eligible to invest in funds falling within Section 3(c)(1) of the Investment Company Act, but who do not otherwise fall within category (i). These investors will be required to meet the higher Portfolio Requirement thresholds.
- Impact on Existing Investors in Rule 4.7 Funds. A CPO must determine whether an investor qualifies as a QEP at the time of sale of an interest in a Rule 4.7 fund to the investor. A CPO will not be required to determine whether existing investors meet the new Portfolio Requirement, or redeem any existing investors that do not meet the new Portfolio Requirement. However, prior to selling any additional interests in a Rule 4.7 fund, the CPO will be required to determine that any investor subject to the Portfolio Requirement meets the new financial thresholds. (See CFTC Release, pp. 31-32.)
- Impact on Existing Rule 4.7 Advisory Accountholders. A CTA must determine whether a person qualifies as a QEP at the time of opening a Rule 4.7 advisory account for the person. Thus, a CTA will not be required to determine whether existing Rule 4.7 accountholders meet the new Portfolio Requirement, or close existing Rule 4.7 accounts of any persons who do not meet the new Portfolio Requirement. However, prior to opening any additional Rule 4.7 accounts, the CTA will be required to determine that an accountholder subject to the Portfolio Requirement meets the new financial thresholds. (See CFTC Release, pp. 31-32.)
- Compliance Takeaways:
- CPOs and CTAs should update subscription agreements and new account documentation for Rule 4.7 funds and accounts to reflect the increased Portfolio Requirements in time for the Compliance Date, which is scheduled for six months following publication of the amended rule in the Federal Register.
- Following the Compliance Date, CPOs should confirm that investors subject to the Portfolio Requirement meet the new thresholds both prior to selling interests in new Rule 4.7 funds, and selling additional Rule 4.7 fund interests to existing investors.
- Following the Compliance Date, CTAs should confirm that persons subject to the Portfolio Requirement meet the new thresholds, both when opening Rule 4.7 accounts for new accountholders, and opening additional Rule 4.7 accounts for existing accountholders.